SHORT-RUN AND LONG-RUN EFFECTS OF THE FINANCIAL INNOVATIONS ON UK MONEY DEMAND IN THE CONTEXT OF A RESTRICTED VAR MODEL

Abstract

This paper investigates the short-run and the long-run behaviour of money demand in the UK between 1990 and 2016 using Vector Error Correction Model (VECM). We chose this model due to endogenous assumption and the co-integrating behaviour of variables in the model. According to the findings of this study, there exists a long run cointegration relationship between money demand (MD) and the dependent variables, namely real GDP, real interest rate (IR), and the sum of the number of direct credits and direct debit (TD) as proxy for financial innovations. The disparity between the value of money demand in period (t-1) and its long run equilibrium value is corrected by the estimated magnitude of the speed of adjustment. However, it was found to be statistically insignificant and carries a positive sign. Specifically, the results of this estimation are as follow: 1) The speed of adjustment toward long run equilibrium is 0.173682, 2) There is not long run causality from GDP, IR and TD meaning that these variables do not have influence on MD, 3) There is short run causality running from GDP to MD, 4) There is short run causality running from IR to MD, and 5) There is no short run causality running from GDP and TD to MD. In other words, in the short-run, TD does not affect money demand nor does in the long-run